A Major Reason Why Retailers Use Markup Pricing is Because It is Easy to Apply.

Setting the right prices for your products is a balancing act. A low price isn't always ideal, as the product might see a healthy stream of sales without turning any profit (and we all like to eat and pay our bills, right?). Similarly, when a product has a high price, a retailer may see fewer sales and "price out" more budget-conscious customers, losing market positioning.

Ultimately, every small business will have to do their homework. Retailers have to consider factors like production and business costs, consumer trends, revenue goals, and competitor pricing. Even then, setting a price for a new product, or even an existing product line, isn't just pure math. In fact, that may be the most straightforward step of the process.

That's because numbers behave in a logical way. Humans, on the other hand—well, we can be way more complex. Yes, you need to do the math. But you also need to take a second step that goes beyond hard data and number crunching.

The art of pricing requires you to also calculate how much human behavior impacts the way we perceive price.

To do so, you'll need to examine different pricing strategy examples, their psychological impact on your customers, and how to price your product.

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Types of pricing strategies

1. Retail price: choosing the right pricing strategy for your brand

Many retailers benchmark their pricing decisions using keystone pricing (explained below), which essentially is doubling the cost of a product to set a healthy profit margin. However, in many instances, you'll want to mark up your products higher or lower than that, depending on a number of factors.

Here's an easy formula to help you calculate your retail price:

Retail price = [cost of item ÷ (100 - markup percentage)] x 100

For example, if you want to price a product that costs you $15 at a 45% markup instead of the usual 50%, here's how you would calculate your retail price:

Retail price = [15 ÷ (100 - 45)] x 100

Retail price = [15 ÷ 55] x 100 = $27

While this is a relatively simple markup formula, this pricing strategy doesn't work for every product in every retail business. Because every retailer is unique, we've rounded up 13 common pricing strategies and weighed the advantages and disadvantages of each to help simplify your decision making.

Retail prices are first set with knowledge of 'what will the customer pay for it.' It starts there. For me, if this came out to a 50% margin, I'd see what increasing the price to $28 or $30 would do. Once it feels good, I would leave it there.

2. Keystone pricing: a simple markup formula

Keystone pricing is a pricing strategy retailers use as an easy rule of thumb. Essentially, it's when a retailer determines a retail price by simply doubling the wholesale cost they paid for a product. There are a number of scenarios in which using keystone pricing can result in a product being priced either too low, too high, or just right for your business.

If you have products that have a slow turnover, have substantial shipping and handling costs, or are unique or scarce in some sense, then you might be selling yourself short with keystone pricing. In any of these cases, a seller could likely use a higher markup formula to increase the retail price for these in-demand products.

On the other hand, if your products are highly commoditized and easily found elsewhere, using keystone pricing can be harder to pull off.

• Pro: The keystone pricing strategy works as a quick-and-easy rule of thumb that ensures an ample profit margin.
• Con: Depending on the availability and the demand for a particular product, it might be unreasonable for a retailer to mark up a product that high.

3. Manufacturer suggested retail price

As its name suggests (no pun intended), the manufacturer suggested retail price (MSRP) is the price a manufacturer recommends retailers use when selling a product. Manufacturers first started using MSRPs to help standardize different prices of products across multiple locations and retailers.

Retailers often use the MSRP with highly standardized products (i.e., consumer electronics and appliances).

• Pro: As a retailer, you can save yourself some time simply by using the MSRP when pricing your products.
• Con: Retailers that use the MSRP aren't able to compete on price. With MSRPs, most retailers in a given industry will sell that product for the same price. You need to take into consideration your profit margins and cost. For example, your business may have additional costs that the manufacturer doesn't account for, like international shipping.

Keep in mind that MSRP is very niche. Consider that although you can set whatever price you want, a large deviation from an MSRP could result in manufacturers discontinuing their relationship with you, depending on your supply agreements and the goal manufacturers have with their MSRP.

4. Multiple pricing: the pros and cons of bundle pricing

We've all seen this pricing strategy in grocery stores but it's common for apparel as well, especially for socks, underwear, and t-shirts. With the multiple pricing strategy, retailers sell more than one product for a single price, a tactic alternatively known as product bundle pricing.

For example, a study looking at the effect of bundling products in the early days of Nintendo's Game Boy handheld console found more units were sold when the devices were bundled with a game rather than sold on their own.

• Pros: Retailers use this strategy to create a higher perceived value for a lower cost, which ultimately can lead to driving larger volume purchases. Another benefit is that you can sell items separately for more profit. For example, if you sell shampoo and conditioner together for $10, you can sell them separately for $7 to $8 each, and that's a win for your business.
• Con: Bundling reduces profits. If the bundle itself doesn't increase sales volume, then you may come up short on profits.

5. Penetration pricing and discount pricing

It's no secret that shoppers love sales, coupons, rebates, seasonal pricing, and other related markdowns. That's why discounting is a top pricing method for retailers across all sectors, used by 97% of survey respondents in a study from Software Advice.

There are several benefits to leaning on discount pricing. The more apparent ones include increasing foot traffic to your store, offloading unsold inventory, and attracting a more price-conscious group of customers.

• Pros: The discount pricing strategy is effective for attracting a larger amount of foot traffic to your store and getting rid of out-of-season or old inventory.
• Cons: If used too often, it could give you a reputation of being a bargain retailer and could hinder consumers from purchasing your products at regular price. It also creates a negative psychological impact toward the consumer's perception of quality. For example, The Dollar Store and Walmart have low prices, but have perceived lower quality associated with their products, regardless of how valid that opinion is.

A penetration pricing strategy is also useful for new brands. Essentially, a lower price is temporarily used to introduce a new product in order to gain market share. The tradeoff of additional profit for customer awareness is one many new brands are willing to make in order to get their foot in the door

For more information on how to build a discount pricing strategy, read these related posts:

• How to Offer Retail Discounts Without Slashing Your Profits
• The Science of Sales: How to Move More Merchandise with Discounts

6. Loss-leading pricing: increasing the average transaction value

We've all done this: we walk into a store lured by the promise of a discount on a hot-ticket product, but instead of walking away with only that product in hand, we end up purchasing several others as well.

If this has happened to you, you've gotten a taste of the loss-leader pricing strategy. With this strategy, retailers attract customers with a desirable discounted product and then encourage them to buy additional items.

A prime example of this strategy is a grocer that discounts the price of peanut butter and promotes complementary products, like loaves of bread, jelly and jam, or honey. The grocer might offer a special bundle price to encourage customers to buy these complementary products together rather than simply selling a single jar of peanut butter.

While the original item might be sold at a loss, the retailer can benefit from having an upsell/cross-sell strategy in place to help nudge more sales. Loss-leading usually happens for products that buyers are already looking for (like bananas at a grocery store) where demand for the product is high, driving more customers in the door.

• Pros: This tactic can work wonders for retailers. Encouraging shoppers to buy multiple items in a single transaction not only boosts overall sales per customer but can cover any profit loss from cutting the price on the original product.
• Cons: Similar to the effect of using discount pricing too often, when you overuse loss-leading prices, customers come to expect bargains and will be hesitant to pay the full retail price. You could also cannibalize revenues if you're discounting something that doesn't increase cart size or average order size.

FURTHER READING: Learn how bundling your products can help you increase your retail sales.

7. Psychological pricing: use charm pricing to sell more with odd numbers

Studies have shown that when merchants spend money, they're experiencing pain or loss. So, it's up to retailers to help minimize this pain, which can increase the likelihood that customers will make a purchase. Traditionally, merchants have accomplished this with prices ending in an odd number, like 5, 7, or 9. For example, a retailer would price a product at $8.99 instead of $9. From a customers' perspective, it looks the retailer has slashed every cent possible off the price. Their brain reads $8.99 and sees $8, not $9, and makes the item seem like a better price.

In William Poundstone's book Priceless, he picks apart eight studies on the use of "charm prices" (i.e., those ending in an odd number) and found that they increased sales by 24% on average when compared to their nearby, "rounded" price points.

But how do you choose which odd number to use in your pricing strategy? The number 9 reigns supreme when it comes to many retail pricing strategies. Researchers at MIT and the University of Chicago ran an experiment on a standard women's clothing item with the following prices $34, $39, and $44. Guess which one sold the most?

That's right—items priced at $39 even outsold their cheaper counterparts priced at $34.

• Pro: Charm pricing allows retailers to trigger impulse purchasing. Ending prices with an odd number gives shoppers the perception that they're getting a deal—and that can be tough to resist.
• Con:At times, charm pricing can seem gimmicky to merchants decreasing trust, while a simple whole-dollar price is clean and perceived as transparent.

8. Competitive pricing: beating out the competition

As the name of this pricing strategy suggests, competitive pricing strategy refers to using competitors' pricing data as a benchmark and consciously pricing your products below theirs.

This tactic is usually driven by the product value. For example, in industries with highly similar products where price is the only differentiator and you rely on price to win customers.

• Pro: This strategy can be effective if you can negotiate a lower cost per unit from your suppliers, while cutting costs and actively promoting your special pricing.
• Cons: This strategy can be difficult to sustain when you're a smaller retailer. Lower prices mean lower profit margins, and so you'll have to sell higher volume than competitors. And, depending on the products you're selling, customers may not always reach for the lowest-priced item on a shelf.

For other products where an apples-to-apples comparison isn't easily discernible, there's a reduced need to enter into price wars. Leaning on brand appeal and focusing on a target customer segment alleviates need to rely on competitor pricing.

9. Premium pricing: above competition pricing

Here, you take the pricing strategy from above and go to the other end of the spectrum. Brands benchmark their competition but consciously price products above their own to make themselves seem more luxurious, prestigious, or exclusive. For example, a premium price works in Starbucks' favor when people pick it over a lower-priced competitor, like Dunkin'.

A study by economist Richard Thaler looked at people hanging out on a beach wishing for a cold beer to drink. They were offered two options in this scenario: purchasing a beer at either a rundown grocery store or at a nearby resort hotel. The results found that people were far more willing to pay higher prices at the hotel for the same beer. Sounds crazy, right?

Well, that's the power of context and marketing your brand as high end. Be confident and focus on the differentiated value you provide to customers and ensure you are still providing value. For example, high customer service, appeasing branding, etc., will provide the necessary value to customers to demand higher prices.

• Pro: This pricing strategy can work its halo effect on your business and products: consumers perceive that your products are better quality and more premium compared to your competitors due to the higher price.
• Cons: This pricing strategy can be difficult to implement, depending on your stores' physical locations and target customers. If customers are price sensitive and have several other options to purchase similar products, the strategy won't be effective. This is why it's crucial to understand your target customers and do market research.

FURTHER READING: Learn how to conduct market research so you can better understand how to price your products, your target customers, and quirks of your chosen niche.

10. Anchor pricing: creating a reference point for shoppers

Anchor pricing is another product pricing strategy retailers have used to create a favorable comparison. Essentially, a retailer lists both a discounted price and the original price to establish the savings a consumer could gain from making the purchase.

Creating this kind of reference pricing (placing the discounted and original prices side by side) triggers what's known as the anchoring cognitive bias. In a study from economics professor, Dan Ariely, students were asked to write down the last two digits of their Social Security number and then consider whether they would pay that amount for items they didn't know the value of, such as wine, chocolate, and computer equipment.

Next, they were asked to bid for those items. Ariely found that students with a higher two-digit number submitted bids that were 60%–120% higher than those with lower numbers. That's due to the higher price "anchor," i.e., their Social Security number. Consumers establish the original price as a reference point in their minds, then "anchor" to it and form their opinion of the listed marked-down price.

The other way you can take advantage of this principle is to intentionally place a higher-priced item next to a cheaper one to draw a customer's attention to it.

Many brands across industries use anchor pricing to influence customers to purchase a mid-tier product.

• Pro: If you list your original price as being much higher than the sale price, it can influence a customer to make a purchase based on the perceived deal.
• Con: If your anchor price is unrealistic, it can lead to a breakdown of trust in your brand. Customers can easily price-check products online against your competitors with a price comparison engine—so ensure your listed prices are reasonable.

11. Price skimming: higher, short-term profits

A price skimming strategy refers to when an ecommerce business charges the highest initial price that customers will pay, then lowers it over time. As demand from the first customers are satisfied and more competitors enter the market, the business lowers the price to attract a new, more price-conscious customer base.

The goal is to drive more revenue while demand is high and competition is low. Apple uses this pricing model to cover the costs of developing a new product, like the iPhone.

Skimming is useful under the following context:

1. There are enough prospective buyers that will buy the new product at a high price
2. The high price doesn't attract competitors
3. Lowering the price only has a small impact on profitability and reducing unit costs
4. The high price is seen as exclusive and high quality

• Pros: Price skimming can lead to high short-term profits when launching a new, innovative product. If you have a prestigious brand image, skimming also helps maintain it and attract loyal customers that want to be the first to get access/have an exclusive experience

It also works when there is product scarcity. For example high-in-demand low-supply prices can be priced higher, and as supply catches up, prices drop.

• Cons:Price skimming isn't the best strategy in crowded markets unless you have some truly incredible features no other brand can mimic. It also attracts competition and can bother early adopters if you slash the price too soon or too much after launch.

12. Cost-plus pricing: a simple markup

Cost-plus pricing, also known as mark-up pricing strategy, is the easiest way to price a product or service. You make the product, add a fixed percentage on top of the costs, and sell it for the final price.

Let's say you just started an online t-shirt business and you want to calculate the selling price for a shirt. The cost for making the t-shirt are:

• Material costs: $5

• Labor costs: $25

• Shipping costs: $5

• Marketing and overhead costs: $10

You could add a 35% markup on top of the $45 it cost to make your product as the "plus" of cost-plus pricing. Here's what the formula looks like:

Selling price = Cost (mark up)

Selling price = $45 (1.35)

Selling price = $60.75

• Pros: The upside of cost-plus pricing is that it doesn't take much to figure out. You're already tracking production costs and labor costs. All you have to do is add a percentage on top of it to set the selling price. It can provide consistent returns should all your costs remain the same.
• Cons: Cost-plus pricing doesn't take into account market conditions such as competitor pricing or perceived customer value.

13. Economy pricing: for low production costs and high volume sales

An economy pricing strategy is where you price products low and gain revenue based on the sales volume. It's typically used for commodity goods, such as groceries or drugs, where the company doesn't have a big brand to support its marketing. The business model relies on selling a lot of products to new customers on a consistent basis.

Setting up economy pricing is similar to setting up cost-plus pricing:

Production cost x profit margin = price

• Pros: Economy pricing is easy to implement, can keep customer acquisition costs low, and is good for customers with price sensitivity.
• Cons: The margins are typically lower, you need a steady flow of new customers all the time, and consumers may not perceive the products to be high-quality.

Pricing strategy template for wholesalers

Once you have your suggested retail price (SRP), you can move forward with creating a wholesale pricing strategy for your products. This is a necessary process for retail brands that want to delve into business-to-business (B2B) sales. B2B buyers usually are more informed than B2C customers—more product aware, competitive aware, and more focused on value (price/service/etc.).

Retailers will sell their products at a discounted price to another business to resell to their own customers. This can increase a brand's reach and introduce its products to new audiences.

If you're selling wholesale and setting a pricing strategy, start with the following steps:

1. Compare the profit you make for individual items and then contrast that to 100x the volume. The difference impacts how much discount you want to provide for bulk purchases. (Then you have the steps to think about what 1,000x looks like.)

2. Calculate the cost of goods manufactured (COGM). This is the total cost of making or purchasing a product, including materials, labor, payment method and terms, and other additional costs necessary to get the goods into inventory and ready to sell.

Costs can be divided into two distinct categories:

• Overhead and capital costs: This is things like building, equipment, utilities, etc.
• Direct costs: This is labor, materials, shipping and insurance, and other costs of goods sold.

Overhead costs are divided by the estimated volume you think you're selling. Direct costs are easier to assign to the cost of selling a product.

Shipping is a hard price to measure here, where depending on the product, bulk quantities impact weight and increase costs to ship.Another key consideration is shipping speed. When selling B2B, you're part of another merchant's supply chain, and as a result, you may need to pay for guaranteed or faster shipping, which increases costs.

A product's COGM can be determined with the following calculation:

Total material cost + total labor cost + additional costs and overhead = cost of goods manufactured

3. Protect your profit margin. Keep in mind that when setting a wholesale pricing strategy, the profit margin should be 50% or more.

Retail margin percentage can be determined with the following formula:

Retail price - cost / retail price = retail margin %

4. Set your direct-to-consumer and business-to-business prices. Create an external retail price for your products listed on your website that your direct customers see and a separate wholesale price you share with wholesale or potential wholesale accounts in the form of a line sheet. When you sell wholesale, you're likely selling a higher quantity in each order, which allows you to sell the products at a lower price.

B2B customers are likely returning customers if the quality/service is good. As a result, it could even make sense to price at initial discounts to "win" the contract/customer over. Doing this as long as you're transparent is a useful way to get long-term sustainable revenue streams.

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Moving forward with the best pricing strategy for you

There's never a black-and-white approach to setting a pricing strategy. Not every pricing strategy will work for every kind of retail business—every brand owner will need to do their homework and decide what works best for their products, marketing strategy, and target customers.

Now that you have a deeper understanding of some of the most common pricing strategies for retail businesses, you can make a more informed choice and create more personalized shopping experiences for buyers by giving them the best price possible.

Illustration by Pete Ryan

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Pricing strategy FAQ

What is a pricing strategy?

Pricing strategy refers to the models a business uses to find the best price for its products. Businesses base the price of their products and services on production, labor, and marketing expenses and then add on a certain percentage so they can maximize profit and shareholder value.

Why is a pricing strategy important?

A pricing strategy is important because it defines the value that your product is worth for you to make and for your customers to use. It also allows you to maximize profit margins, plus create competitive advantage by setting prices that help maintain market share.

What are examples of pricing strategies?

• Keystone pricing
• Multiple pricing
• Penetration pricing
• Loss-leading pricing
• Psychological pricing
• Bundle pricing
• Economy pricing
• Cost-plus pricing
• Premium pricing

What does MSRP stand for?

The manufacturer suggested retail price (MSRP) is the price a manufacturer recommends you sell its product for. MSRP is also referred to as the 'list price.'

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Source: https://www.shopify.com/ph/blog/pricing-strategies

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